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Know your REITs — Private versus public REITs

By
Scott P. Hastings

August 23, 2013

In recent years, private real estate investment trusts (REITs), which are not registered with the Securities and Exchange Commission (SEC) and therefore do not trade on national stock exchanges, have been the subject of increased regulatory scrutiny as investors have suffered significant losses and, in certain instances, faced potential liquidity difficulties. Despite these setbacks, advisors have still been known to pitch private REITs as a better alternative to publicly traded REITs, capable of generating strong income potential, possibly with lower share price volatility.

However, we believe these claims are unfounded and that investors would do well to acquaint themselves with the potential drawbacks of private REITs compared to those of public REIT investments. Although private REITs are similar to public REITs in that they generally seek high levels of continuing income and capital appreciation through real estate investments, they may also differ in crucial ways. All in all, we believe these differences (outlined below) make private REITs riskier, while offering less liquidity than their publicly listed counterparts.

Public REITs

Private REITs

Access to capital markets

Have a wide range of financing sources, including public equity, public debt, preferred shares, commercial mortgage-backed securities, secured debt, bank debt, and lines of credit.

Generally are limited to secured debt or private fund raising.

Dividends

Required to pay out 90% of taxable income. Dividends tend to grow with cash flows of the company.

Deciding whether to pay distributions (and the amount of such distributions) is within the discretion of a private REIT’s board of directors.

Liquidity

Can be bought and sold with relative ease, like any other publicly-traded stock.

Not traded on public stock exchanges.

The existence of, and terms of, any redemption programs vary by company and are generally limited in nature. If liquidity is provided, it often requires finding a buyer at a price that cannot be readily determined.

Transaction costs

Front-end underwriting fees in the form of a discount may generally be 7% or more of the offering proceeds. Brokerage costs are the same as for buying or selling any other publicly traded stock.

Front-end fees may run as high as 15%, with relatively large annual fees (in comparison to public REITs).

Management alignment

Typically self-advised and self-managed. REIT’s executive management is overseen by an independent board of directors as well as stockholders, who have the power to influence a company’s decisions. Management’s compensation is typically tied to shareholder returns.

Typically externally advised and managed. The overlap of key individuals and entities in multiple aspects of a REIT’s business can lead to substantial conflicts of interest, in our opinion. The advisor is typically paid an advisory fee that is paid based on the size of the REIT rather than its performance.

Independent directors

Stock exchange rules require a majority of directors to be independent of management. NYSE and NASDAQ rules call for fully independent audit, nominating, and compensation committees.

Not required.

Disclosure obligation

Required to make regular financial disclosures to the investment community, including quarterly and yearly audited financial results with accompanying filings to the SEC.

Because they are not regulated, private REITs are not required to file with the SEC. As a result, very little public information exists about their structure and holdings.

Performance measurement

Numerous independent benchmarks are available for tracking the performance of public REITs. A wide range of analyst reports are also available to the public.

No public or independent source of performance data is available.

Share valuation

Have continuously updated prices that reflect the supply and demand for shares

Share prices are set by the sponsor and are routinely kept at this initial offering price, regardless of changes in the true value of the underlying real estate portfolio.

This could result in significant price discounts when the portfolio is “marked to market.” (That is, accounting for the actual market value of a security, rather than its book value.)

Given the advantages public REITs offer in comparison to private REITs, we believe investors seeking exposure to real estate investments should consider publicly-traded REITs or mutual funds that invest in public REITs. The expenses in these products are more transparent on a relative basis, and may cost less than what brokers often charge for participating in private REITs. In our view, certain types of publicly-traded REITs also have the potential to offer investors broader exposure to properties across the world.

It should be noted that, despite these potential advantages, both public and private REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations. This is neither an exhaustive nor definitive list of the differences between public and private REITS, and the characteristics of individual REIT investments, both public and private, may vary.

The views expressed represent the Manager’s assessment of the market environment as of August 2013, and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager’s views.

Carefully consider the Funds' investment objectives, risk factors, charges, and expenses before investing. This and other information can be found in the Funds' prospectuses and their summary prospectuses, which may be obtained by visiting delawarefunds.com/literature or calling 800 523-1918. Investors should read the prospectus and the summary prospectus carefully before investing.

IMPORTANT RISK CONSIDERATIONS

Investing involves risk, including the possible loss of principal.

Narrowly focused investments may exhibit higher volatility than investments in multiple industry sectors. "Nondiversified" funds may allocate more of their net assets to investments in single securities than "diversified" Funds. Resulting adverse effects may subject these Funds to greater risks and volatility.

REIT investments are subject to many of the risks associated with direct real estate ownership, including changes in economic conditions, credit risk, and interest rate fluctuations.

A REIT fund's tax status as a regulated investment company could be jeopardized if it holds real estate directly, as a result of defaults, or receives rental income from real estate holdings.

International investments entail risks not ordinarily associated with US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations. Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.

There is no guarantee that dividend-paying stocks will continue to pay dividends.

Scott P. Hastings

More from Scott P. Hastings

Scott P. Hastings biography

Scott P. Hastings, CFA, CPA

Vice President, Portfolio Manager

Scott P. Hastings currently serves as a portfolio manager for the firm’s real estate securities and income solutions (RESIS) group, a role he assumed in July 2016. Previously, he was a senior equity analyst for the RESIS group, where he performed fundamental bottom-up stock research across several subsectors of the domestic real estate investment trust (REIT) universe, and focused on opportunities in the United States, Canada, Europe, the United Kingdom, and Australia for the firm’s global real estate securities strategy. Hastings joined Macquarie Investment Management (MIM), which includes the former Delaware Investments, in 2004 as an analyst for the firm’s RESIS group. Prior to joining the firm, he was a senior auditor with Deloitte & Touche. Hastings earned a bachelor’s degree from Providence College and an MBA from Vanderbilt University. He is a member of the American Institute of Certified Public Accountants and the CFA Society of Philadelphia.

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Other than Macquarie Bank Limited (MBL), none of the entities noted are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of these entities, unless noted otherwise.

The Funds are distributed by Delaware Distributors, L.P., an affiliate of Macquarie Investment Management Business Trust (MIMBT), Macquarie Management Holdings, Inc., and Macquarie Group Limited. Macquarie Investment Management (MIM), a member of Macquarie Group, refers to the companies comprising the asset management division of Macquarie Group Limited and its subsidiaries and affiliates worldwide.

Other than Macquarie Bank Limited (MBL), none of the entities noted are authorised deposit-taking institutions for the purposes of the Banking Act 1959 (Commonwealth of Australia). The obligations of these entities do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that entity, unless noted otherwise.

The Funds are distributed by Delaware Distributors, L.P., an affiliate of Macquarie Investment Management Business Trust (MIMBT), Macquarie Management Holdings, Inc., and Macquarie Group Limited. Macquarie Investment Management (MIM), a member of Macquarie Group, refers to the companies comprising the asset management division of Macquarie Group Limited and its subsidiaries and affiliates worldwide.